Right now I’m analysing some of the most popular companies in the FTSE 100 to establish if they are attractive long-term buy and forget investments.
Today I’m looking at United Utilities (LSE: UU) (NASDAQOTH: UUGRY.US)
What is the sustainable competitive advantage?
United Utilities’ main competitive advantage is its virtual monopoly over the provision of water and related services in the North West of England.
However, despite the company’s near monopoly over the North West’s water market, United Utilities cannot set its own prices. Indeed, the prices that the company is allowed to charge customers are strictly regulated by the water regulator, Ofwat.
What’s more, Ofwat only reviews the company’s pricing structure every five years, removing the company’s ability to increase prices if costs suddenly expand.
That said, despite these limits imposed on the company, United Utilities still achieves a solid operating profit margin for investors.
During its last reported financial year, United Utilities had an operating profit margin of 38%. In comparison, peers Severn Trent and National Grid had operating profit margins of 27% and 28% respectively for the same period.
Nonetheless, due to rules set out by Ofwat, United Utilities has to spend a certain amount on utility infrastructure every year, capping the company’s ability to generate abnormal levels of profit.
For example, during 2013 the company generated £630 million in cash from operations but spent £661 million on infrastructure projects.
Thanks to this high level of capital spending, net debt has ballooned 20% during the past two years.
Company’s long term outlook?
As one of the premier utility companies for Northern England, United Utilities is unlikely to be displaced from its position in the industry anytime soon.
Specifically, United Utilities’ existing infrastructure for the transportation, storage and treatment of water would be hard for competitors to replicate. This means that industry barriers to entry are high.
In addition, the demand for water and water treatment services is only going to grow over the longer term.
Foolish summary
All in all, United Utilities’ dominance over the water market in North East England makes the company looks like a great ‘buy and forget’ share. Still, there are risks facing the company, such as the inability to raise prices without the go-ahead from Ofwat and rising levels of debt.
Nonetheless, overall I rate United Utilities as a good share to buy and forget.
